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An Example of How the Complex Takes Control - A Board Dominated by Hired Managers Levitates Its Hired CEO's Pay

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The Indianapolis Star published the latest story about anti-gravity health care executive compensation. The report emphasized how the largest hospital systems in the metropolitan area raised CEO pay faster than any reasonable metric:

CEO pay is up, sharply in some cases, at Indianapolis' four large hospital groups, as the systems have grown and dumped more responsibilities on their top leaders.

Total pay for those CEOs rose anywhere from 15 percent to 53 percent from 2008 to 2010. While experts say the pay is in line with executive compensation at other large hospital groups, the rate of the increases far outpaces the minimal wage gains that area health-care workers (1.7 percent) and hourly workers (3.1 percent) have seen over the same time.

The rising CEO pay comes at one of the shakiest financial periods ever for hospitals, as they struggle with cuts in reimbursements for care from federal Medicare and Medicaid programs and private insurers.

CEO Pay Up More than Revenue

Pay at specific health care systems also rose faster than revenue. At the Indiana University Health System:

At the top of the best-paid list: IU Health's President and Chief Executive Daniel F. Evans Jr., who pulled down $2.08 million in compensation in 2010, up 17 percent from 2008. Subtracting Evans' retirement payouts, which vary year to year, his base pay jumped 19 percent since 2008.

However,

From 2008 to 2010, IU Health has seen revenue grow 10 percent to $2.46 billion,...

At St Vincent Hospital and Health Care

Close behind comes Vincent Caponi, CEO of St. Vincent Hospital and Health Care Center, who took in $1.86 million in 2009-10, a two-year jump of 44 percent, or 64 percent when retirement is removed.

However,

Revenue over the two years rose 28 percent at St. Vincent,...

At Franciscan Alliance,

Robert Brody of Franciscan Alliance earned $1.27 million in 2010 (53 percent more than in 2008),...

However, over that period revenue only rose 17%.

At Community Health Network,

Bryan A. Mills, the relatively new CEO of Community Health Network, received $1.35 million, or 15 percent more than his predecessor, William Corley, collected in 2008. (Corley retired in 2009.)

while revenue only rose 4%.

The Usual Talking Points

At this point, it should come as no surprise that hospital leadership trotted out the same old talking points to account for the ever upward trajectory of CEO pay as used in other areas and to account for the pay of leaders of other kinds of health care organizations (look here). These included...

We Pay What Everyone Else Pays

It was easy to find a professional compensation consultant to repeat this one:

Jim Otto, senior principal in Atlanta for the Hay Group, a consultant on executive benefits, said pay to top hospital CEOs in Indianapolis appears in line with rising compensation, including retirement benefits and bonuses, being paid nationally to most large-system hospital executives.

CEOs Work Hard and Are Brilliant

So we read:

At IU Health, formerly Clarian Health Partners, where Evans has been CEO since 2002, 'The system's grown significantly. It makes us think twice about the difficulty of running such a system. We literally cover the entire state of Indiana. And much of that has been under Dan's oversight,' said Charles Golden, an IU Health board member and chair of its compensation committee.

Also,

Golden says Evans 'has done a really superb job. Almost everything favorable to our system has been positive in his time.'

Here is the version pertaining to St Vincent's

Caponi 'is on an airplane and out of town a good bit, running a much bigger area' for Ascension, said Bill Estes, chairman of St. Vincent's board. 'That's the way we justify (higher CEO pay) and feel comfortable with that.'

High Pay is Needed to Attract Competent, if not Brilliant People

From Mr Otto, the compensation consultant:

Large hospital groups make certain they pay similar to their peers to remain competitive.

One reason for rising pay, Otto says: 'These aren't easy jobs. They are not easy to fill. The candidate pool isn't terribly large.'

Furthermore, Mr Golden, from the IU Board, added,

'Unless you want to default to mediocrity, I suppose you can do that (cut CEO pay),' he said. 'But I don't think that's where we are going. I don't think these (hospital) systems will get any easier to manage.'

Talking Points Sans Justification

As in previous cases, no one that reporter Jeff Swiatek could find provided any specifics to back up these talking points. It is striking that those who stewarded all the major hospital systems in this one area felt the need to raise executive pay substantially faster than the rate of rise of revenue, that is from 1.7 times to 3.75 times the rate of revenue rise.

Why Are Hospital Boards So Nice to CEOs?

In the interests of full disclosure, I noticed this article because reporter Jeff Swiatek chose yours truly, plus fellow blogger Dr Howard Brody (look here) to comment for it.

'Whenever the nonprofit sector starts acting more like the for-profit sector, I start to get worried,' said Dr. Howard Brody, director of the Institute for the Medical Humanities. 'It just becomes crony capitalism. If one executive gets paid $3 million instead of $1 million, then every executive wants $3 million. It just becomes a vicious cycle of inflation of CEO benefits.'

Also, I suggested:

Put more noncorporate members on hospital boards because they'd be less inclined to endorse large compensation packages that are more typical of for-profit companies.

'Boards are populated by wealthy executives, who themselves are getting increasing compensation, rather than by community representatives or patient representatives,' Poses said.

Could the Composition of the Board Explain Excess Deference to the CEO?

I made the above comments after hearing approximations of the compensation given out by the hospital systems, but without any knowledge of the composition of the boards that approved that compensation. I am guessing that Dr Brody also was not told anything about board composition when he suggested the possibility of crony capitalism.

However, now that the article is out, I think it makes sense to look at the composition of at least one of the boards involved. I chose IU Health, since it is the largest of the systems, paid the most to its CEO, and was kind enough to list board members' brief biographies on a web-page. Here they are, listed with their primary affiliations, and some notable other affiliations.

- Judge Sarah Evans Barker, former federal district court judge.- Dr D Craig Brater, "dean of the Indiana University School of Medicine and director of IU Medical Center." Also on the Board of Advisors of Spring Mill Venture Partners, "an early stage venture capital firm focused on investing in high-growth information technology and life sciences companies;" recipient of consulting and travel money from Pfizer (per ProPublica); and who was listed as having "a financial interest/relationship or affiliation in the form of: Consultant for AstraZeneca Pharmaceuticals; BioGen, Inc.; Forest Laboratories; Merck & Co., Inc.; Pfizer Inc.; and Pharmacia and Upjohn Company" per CMECorner.- William R Cast, "CEO of NoMore Clipboard, an online, patient-controlled personal health record management system."- Thomas W Chapman, "president and CEO of The HSC Foundation in Washington, DC, the parent corporation for two subsidiaries, The HSC Pediatric Center and Health Services for Children with Special Needs. He was previously senior associate vice president for Network Development and Professor of Health Services Management and Policy at George Washington University Medical Center in Washington, DC."- Bishop Michael J Coyner, "Bishop of the Indiana Area United Methodist Church"- J Scott Davison, "chief financial officer for OneAmerica and its affiliated companies," and member of the board of directors for Indiana Bond Bank."- Daniel F Evans Jr - CEO of IU Health, also member of the board of Lakeland Financial Corp, (per Bloomberg)- Charles E Golden, "retired from Eli Lilly and Company in 2006 as executive vice president and CFO and a member of the board of directors. He was previously a corporate vice president of General Motors...." He is also currently on the boards of Unilever, which makes health care related products, and Hill-Rom, which makes medical devices and supplies.- David W Goodrich, "retired in 2005 as president and CEO of Central Indiana Corporate Partnership, Inc."- V William Hunt, "chairman of Hunt Capital Partners, LLC, a venture capital and consulting firm based in Indianapolis. Until August 2001, he was the vice chairman and president of ArvinMeritor Inc...."- Dr James E Lingeman, "long-standing member of the IU Health Methodist Hospital medical staff," but also according to a 2009 American Urologic Association Education and Research paper, Consultant or Advisor to, and Meeting Participant or Lecturer for Boston Scientific Corp and Lumenis, scientific investigator for Boston Scientific and Olympus, investor in Beck Analytical Laboratories and Midstate Mobile Lithotripsy, and having "Other" financial relationships with Beck and Midstate.- Angela Barron McBride, " distinguished professor and university dean emerita at Indiana University School of Nursing"- Michael A McRobbie, "Indiana University President," also on the board of OneAmerica (look here).- Anne Nobles, "senior vice president for Enterprise Risk Management and chief ethics and compliance officer for Eli Lilly and Company."

When considering the composition of this board, note that members of non-profit organizations' boards generally are said to have three duties, as per BoardSource:- The Duty of Care: "a board member owes the duty to exercise reasonable care when he or she makes a decision as a steward of the organization."- The Duty of Loyalty: "a board member must give undivided allegiance when making decisions affecting the organization. This means that a board member can never use information obtained as a member for personal gain, but must act in the best interests of the organization."- The Duty of Obedience: "The duty of obedience requires board members to be faithful to the organization's mission. They are not permitted to act in a way that is inconsistent with the central goals of the organization."

The Duties of Care and Obedience require board members to exercise prudent and reasonable supervision over hired managers, and provide these managers reasonable pay and incentives. However, boards dominated by hired managers may put the interests of such managers ahead of their organizations' missions.

So of the 14 members of the IU Health board, 8 are current or retired top level corporate executives or corporate board members, 4 of which have such leadership positions at financial service companies, (two at OneAmerica). In addition, 5, including 4 apparently ex-officio members, had or have top leadership positions in academic institutions. The board also included one Methodist Bishop and one federal judge. All but two board members are thus current or former top level hired managers of for-profit corporations or non-profit organizations.

Thus this board is largely populated by executives who are likely to be wealthy. Thus it is similar to many other boards of health care corporations (e.g., look here and here) and non-profit organizations (e.g., look here, here, and here) which we have discussed. It stands to reason that boards dominated by hired managers will feel comfortable with and look kindly on the hired managers whom they are supposed to supervise, and view their compensation sympathetically. Thus such boards may not exercise the Duties of Care and Obedience.

Furthermore, the Duty of Loyalty requires boards not to be affected by conflicts of interest.

However, many of the IU Health board members have financial relationships that could be considered conflicts of interest. Two have or had executive positions at the same pharmaceutical company, Eli Lilly, one of whom also was on the board of medical device and supply company. In addition, both of the doctors on the board have or had significant disclosed financial relationships with drug, device, or biotechnology firms. Again, it is like other boards affected by such conflicts that we have discussed. Again, such boards may not exercise the Duty of Loyalty.

Summary

Combined with other examples of the composition of boards of for-profit health care corporations, and non-profit health care organizations, the latest example suggests the complex has taken control. Nearly every board we have scrutinized is dominated by hired managers of other companies, and salted with conflicts of interest. It seems likely that such boards will put the interests of hired managers ahead of those of the shareholders of for-profit corporations, and ahead of the missions of non-profit organizations.

The complex that has taken control looks like a confederation of hired managers. In 2003, five years before the fall of Lehman Brothers ushered in the global financial collapse, John C Bogle warned of the "grotesque transformation" of capitalism into an oligarchy of hired managers:

The root causes of the disease in our system are deep, and the remedies that are required to cure it will not be easy to come by. For what we have witnessed in the failure of corporate governance in America has been, as journalist William Pfaff described it, 'a pathological mutation in capitalism.' He was right on the mark. The classic system—owners capitalism—had been based on a dedication to serving the interests of the corporation’s owners, maximizing the return on their capital investment. But a new system developed—managers capitalism—in which 'the corporation came to be run to profit its managers, in complicity if not conspiracy with accountants and the managers of other corporations.' Why did it happen? 'Because,' in Mr. Pfaff’s words, 'the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.'

This plague of managers' capitalism seems not to have spared health care, and to have infected the non-profit as well as public for-profit sphere.

To stave off the coming dystopia, we must return the control of for-profit corporations, including health care corporations, to their owners, and stewardship of non-profit organizations to those who will put their missions ahead of self-interest.